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UTILITY WEEK | 29TH JANUARY - 4TH FEBRUARY 2016 | 15 Finance & Investment Analysis I n world affairs, 1989 was a big year, memorable for the fall of the Berlin Wall and the collapse of communism in much of Eastern Europe. The changes there since those halcyon days have been massive. In the UK, 1989 saw the controversial privatisation of the water sector. Ten com- panies were floated, led by Thames, which reputedly viewed itself as water's British Air- ways, while the other nine were sometimes relegated to the status of country cousins, including Severn Trent. Remarkably, in the intervening 26 years, while other major companies have under- gone deep-seated change, Severn Trent remains essentially the same, namely the monopoly supplier of water and sewerage services to around 3.7 million households centred on the Midlands. Aside from its acquisition in 1991 of Biffa, the waste company that it subsequently demerged, and the acquisitions of a few minor businesses in the UK and in the US, its structure has remained intact. Boring maybe – and hardly in line with the "conquering the world" philosophy that some ambitious water executives held at flotation. Severn Trent has effectively "stuck to the knitting", as the expression has it, and avoided the high-profile non-core mishaps that befell many of its competitors, including Thames and Anglian. At flotation, there had been concerns about Severn Trent's formidable investment programme. Although the water and sewer- age facilities in Birmingham during the lat- ter part of the 19th century were well ahead of their time, other urban centres, including depressed Wolverhampton, the Potteries cen- tre of Stoke and war-torn Coventry, all had pressing sewerage infrastructure backlogs. In recent years, investment levels have remained high, with £547 million being spent in 2014/15. Over the current five-year regulatory period, Severn Trent will continue to invest heavily. Significantly, Severn Trent's supply base remains broadly unchanged, although it did absorb many former statutory water com- panies prior to privatisation. Subsequently, only East Worcester, with just 100,000 cus- tomers, was acquired in 1993. Rather oddly, perhaps, Severn Trent – despite being the only land-locked water and sewerage company – did make a pitch to acquire South West – and its beach chal- lenges – in 1996. But, like the similar Wessex initiative, this failed, leaving South West the core element within the publicly-quoted Pen- non Group. Given its large supply base at the heart of England, and its comparatively low water charges, Severn Trent was better placed than most to develop a multi-utility supply busi- ness. However, unlike Scottish Power, United Utilities and the ill-fated Hyder (Welsh Water), it did not pursue this route. And looking at the problems that Hyder in par- ticular faced, Severn Trent's investors will not regret this unadventurous – but prudent – decision. Severn Trent has, though, developed vari- ous small non-core businesses, including sci- entific services, although none has provided the breakthrough returns (which have stalled recently) of Pennon's Viridor. It is, though, becoming increasingly involved with renew- able energy and plans to invest £190 million in such projects over the next five years Investors have benefitted substantially from Severn Trent's cautious approach. Not only have they received a decent dividend flow, but there has also been impressive cap- ital appreciation. In 1989, the flotation price was 240p, with Severn Trent being sold – on partly-paid basis – on a yield exceeding 7 per cent. The share price is now c£21. While various adjustments need to be made to calculate an exact outperformance, Severn Trent's returns have more than tre- bled against the FTSE-100 Index. With its strong core business focus, Ofwat and its periodic reviews are critical to Sev- ern Trent's financial health – and its ability to meet investors' dividend growth expecta- tions. In fact, Severn Trent has enjoyed good periodic reviews, with only the 1999/2000 review, undertaken by Sir Ian Byatt, being seen as tough. Subsequently, the periodic reviews have been benign, although Ofwat's latest determination under chief executive Cath- ryn Ross was far more searching and rigor- ous – as Bristol has discovered to its cost. Indeed, while water prices have increased substantially in real terms since flotation, Severn Trent's customers currently pay the lowest annual charges nationwide – an aver- age £329. More immediately for Severn Trent, the market remains on the lookout for a renewed bid. Back in 2013, Severn Trent's board bravely rejected a private equity bid of £22 a share, in the expectation that, once the peri- odic review was done and dusted, its share price would top this figure. Last October, it did so, but it has fallen back subsequently as the market frets about economic uncertainty: there has been a dire trading start to 2016. Deflation and asset sell-downs are two recurring themes that have become more prominent recently. If they persist, then Sev- ern Trent investors may have to wait rather longer for a renewed bid. But, for Severn Trent's chief executive, Liv Garfield, and her team, the priority has to remain managing the core business and achieving significant outperformance of Ofwat's 2014/15 determi- nation, while simultaneously delivering real dividend growth, albeit from a slightly lower base than previously. Nigel Hawkins, director, Nigel Hawkins Associates Severn Trent in pole position As the market anticipates further M&A in water, Nigel Hawkins assesses the prospects of Severn Trent, a prime target that has fought off the overtures of private equity once before. SEVERN TRENT SHARE PRICE 2400 2200 2000 1800 1600 1400 1200 1000 800 600 400 1997 2000 2003 2006 2009 2012 2015